Legal Question in Real Estate Law in California

Re: Converting Rental Property and Avoiding a Tax Penalty

The rules are somewhat complex and differ depending upon how long you held the property and how aggressively you've depreciated it. The rules are found in Internal Revenue Code section 1250.

The concept is that income-producing real estate can be depreciated on an accelerated basis, but a personal residence cannot. So, when property is converted back to personal use, the excess depreciation (accelerated vs. straight-line) is "recaptured" and treated as ordinary income rather than capital gains, which would be taxed at a lower rate. It is a rule to prevent tax shelters based on early and artificial ending of rental operations. The amount treated as ordinary income phases out at a rate of 1% per month in many cases. On this basis, I would say the answer to your question MIGHT be 100 months, BUT (a) this rule doesn't fit all cases; (b) other economic factors in your life might be more important than the tax saving, especially if you are in a lower bracket; and (c) the terms of your divorce settlement may affect your tax liability and other aspects of your economic outlook in ways that I can't assess.

You should ask a tax advisor to look at the specifics of how this property was acquired and depreciated, the advise you based on your personal tax situation and other factors.